Question

The New York Times reported…That subway ridership declined by five (5) million fewer riders in December, 1995, the first full month after the price of the token increases by + $.75 to $2.00 (+ 60%) than in the previous December. This resulted in a 15 % decline in riders.

> With this information, estimate the Price elasticity of Demand (PED) for subway rides;

> According to your analysis, what happens to the Transit Authority’s total revenue when the fare rises? Explain ?

>Why might your initial elasticity (PED) calculation be unreliable?

Answer 1

Price increases from $0.75 to $2 which means %change in price = [(2 - 0.75) / 0.75] * 100 = 166.67%

% decline in riders = 15%

a) Elasticity of demand = %change in quantity demanded / %change in price

Elasticity of demand = 15% / 166.67% = 0.09

b) As elasticity of demand is less than 1 or we can observe that % increase in price is much more than %change in quantity demanded, demand must be inelastic. Its total revenue must have increased.

c) Elasticity of demand can be unreliable only in one case possible that is if we calculate elasticity using arc method while the above method used is point elasticity of demand. If change is too small, arc coverges to a point. Point elasticity of demand could give a different number with a small gap.